Wednesday, January 7, 2009

On Externalities

There was a recent post on Slashdot, where a submitter suggested that compact fluorescent light bulbs, though advertised as environmentally beneficial, were actually harmful given the carbon and fossil fuel use of transporting them. In the event, the claim looks to be false (incandescent bulbs must also be shipped, and the efficiency gain far outweighs the fuel cost within a few days). What if it wasn't, though? Some smart people seem to think that the ethanol push is at best an expensive wash, and at worst a waste of money, energy, and resource allocation. Does the production of a Prius battery harm the environment more than the excess fuel consumption and carbon production of a conventional auto? As consumers, do we have to Snopes all of this?

Well, yeah, the Libertarians want you to take charge here as a consumer. If a company does something you don't want, quit paying them to do it. If you don't know, look to a watchdog group that can figure these things out for you. And so on.

The Democrats naturally look to the government to look out for us, regulating or taxing away the bad stuff, subsidizing the good stuff, etc.

The Republicans, far as I can tell, don't care and want you to shut up and keep buying stuff from their donors.

What's going on here?

For starters, the vocab: in a transaction between two parties, any side-effects felt by third parties are known as externalities: effects that are external to the transaction. If the power company sells you power that was produced by a polluting factory that's in my backyard, I'm suffering from an externality. Externalities can be positive or negative.

There's a cool theory, called Pigovianism after the economist that crafted it. The way the theory goes: government should tax transactions that produce negative externalities, in proportion to the value of the damage that they do. The taxed producers will pass that cost onto the consumers, who now find the previous externality "internalized," that is priced into their transaction. In our CFL vs incandescent scenario above, Pigovian taxes on carbon and fossil fuel consumption would factor in the cost to society of shipping bulbs. A consumer wouldn't need to educate himself, read slashdot to get the math on the matter, or anything. Just buy the bulb that does the job, using price as a consideration.

Like I said, it's a pretty cool theory. There is however a pretty big hole - how the heck do we know what shipping a CFL bulb from China costs society in terms of pollution and non-renewable resource consumption? How do you put a dollar amount on that? It depends on who you ask, no? Ask a global warming skeptic, and he'll place way less value on the carbon expenditure. The matter of fossil fuels depends on whether you think we've hit peak oil production yet.

Any government agency that gets involved in Pigovian taxes will find itself highly susceptible to regulatory capture. That is, the folks doing the regulating will come largely from the regulated industry. They'll have friends in that industry, and they'll most likely plan on working in the industry after they finish government service. The costs to the regulated industry will dwarf the salary of the civil servants imposing those costs by such a margin that corruption becomes awfully tempting - spend a few grand here and there on gifts, or suffer millions in extra taxes, paperwork and regulatory hassle? Finally, industry players will waste resources on regulatory arbitrage, engaging in inefficient behavior in order to navigate through tax loopholes, etc. We see this all the time, from pharmaceutical companies to defense contractors to wall street bankers. Suffice to say that while the government might help here, it won't be a perfect solution. Government is large, slow, inefficient, and frequently at a game theoretical disadvantage in these situations.

So, it's back on us consumers again. To the extent that we as consumers worry about the environment, or the fate of the whales, or whatever the externality of the day might be, we need more information than price when evaluating products. Will that laptop leach chemicals into the ground after you're done with it? Were the metals in it excavated by child minors in Africa, working under apalling conditions? This is simply too much for us to handle.

So we turn to the watchdogs. Sierra club, PETA, Cato, you name it, there's a group for it. The watchdogs have some inefficiencies too. Their leaders for instance tend to fight hard enough and long enough that they become radicalized, opposing policies because they dislike the actors, rather than opposing actors because of sensible objections to policies. Organizations are also in competition for donations, and no one donates to a cause when everything is going pretty well, so there's a strong incentive to exaggerate claims and engage in sensationalism. That sensationalism then emboldens opponents, radicalizing them in the fight as well.

We count on Sierra and PETA to do the research that we don't have the time or expertise to do for ourselves, in the name of keeping government and corporate actors honest. But who keeps Sierra and PETA honest? Do we need a non-profit watchdog? If so, who would watch them?

Should we just watch documentaries like Inconvienient Truth and Sicko, running with whatever makes sense to us? How in that system do we guard against sophistry and demogoguery?

This is a tough problem, and much as your Republican friends might poo-poo it as the moaning of a wealthy liberal elite with nothing better to worry about, it's important. Global warming might well be a big deal, the oil isn't going to last forever, and as more and more countries industrialize, we have to recognize that the current American way of life probably won't scale from 300 million Americans to 6 billion (and growing) world citizens.